Saturday, March 31, 2007

Subprime. It isn't just for Homes.

Last week this blog argued that the subprime mortgage meltdown would spread to other aspects of the subprime lending: credit cards, auto loans, subprime consumer credit. Today we got news that even Harley Davidson’s motor hogs are being financed with subprime loans: 20% of their hogs loans are subprime and the 30-day delinquency rate on such loans has increased from a 3.6% between Q1 of 2005 and Q2 of 2006 to 5.18% in Q4 of 2006, an almost doubling of delinquency rates in two quarters.....In conclusion, individuals or households who have subprime mortgages, subprime credit cards, subprime auto loans (and some even Harley’s hogs subprime loans) are likely to experience multiple sources of debt servicing difficulties that, in bad times, tend to pile on each other and worsen such individuals’ credit rating. The fact that such subprime borrowers are also mostly lower income individuals with high income volatility, most at risk of job loss when the unemployment rate rises and more subject to be victim of predatory lending practices by an entire subprime lending industry is the reason why their plight is becoming a leading political issue in Washington. But, as it was discussed in previous blogs here and will be discussed more in forthcoming ones, the plight of subprime borrowers is only a mirror of an entire “subprime economy” where many near-prime and even prime borrowers have similar high debt ratios, falling wealth given the fall in home prices, resetting ARMs, rising debt servicing difficulties and uncertain income paths. This is why this is not just a niche subprime mortgage. The US is now being dragged into a subprime performance and is at a serious risk of a hard landing this year.

Bill Gross has argued that the most harmful effect of the subprime fiasco is the tightening of credit (lenders become more cautious thus leading to fewer loans thus leading to fewer homes sold thus leading to price drops thus leading to slower consumer spending, etc). It seems like the damage being spread across several different types of credit increases the risk of that happening. If folks figure out that Mortgage Based Securities aren't the only ship taking on water it seems the appetite for Debt of all sorts is bound to decrease on the street. Resulting from that will be the return of the missingrisk premium over Treasury rates (which incidentally will finally solve Greenspan's Conundrum once and for all).

Credit card lenders have been preying upon low income borrowers even before Congress let them rewrite the bankruptcy laws. The Domestic automakers have been using lots of subprime lending to move the metal (in spite of that the auto manufacturing sector is in recession now). Payday lenders have been shrugging off all attempts to regulate them. There are all manner of shoes yet to drop in the subprime credit unraveling.

One thing that seems to be flying under the radar is that a lot of these foreclosures and delinquencies are happening in the rust belt where home prices have been stagnant or declining for some time now. Subprime lenders have been aggressive in these areas as well as the "bubble zones" on the coasts. As long as the public face of the subprime mess is speculators in high price areas policy solutions are going to turn the wrong way.